NET Stock has robust sales growth but stronger reasons to sell
Cloudy (NYSE:REPORT) helps make everything online secure, fast, and reliable. The company is doing its best to eliminate fears of cyberattacks, increase productivity and improve remote working for its customers. This is a very solid economic moat for NET stocks but, at the moment, it is not enough to make it worth it.
Cloudflare gives businesses an edge in making strategic decisions by making digital tasks safer and faster. By developing a globally connected cloud network with technology, the company is building a better Internet. With rapid technological advancements and Web 3.0 on the horizon, there will be increased demand for Cloudflare’s services to support critical industries. All together, this definitely builds a bull case for the cloud company.
This is at least the start of a bullish case for Cloudflare, but there is also a valid bearish case. Both cases have their own distinct arguments. Decide which side has the more plausible scenario and pick your side based on facts, not emotions.
Cloudflare: the bullish scenario
The global cloud service provider released a third quarter 2021 earnings report that showed the strength of several key metrics.
For the three months ended September 30, 2021, Cloudflare saw a 51% increase in revenue compared to the same period a year ago. As well as an increase in large customers with over $100,000 annualized revenue of around 71% to 1,260 from 736 in Q3 2020.
The compound annual growth rate (CAGR) of total revenue from the year 2018 to the end of September 2021 was 50%. And for large customers alone, it was 67% from Q3 2019. Investors with a preference for growth stocks are likely to like Cloudflare.
Their business scalability is also impressive with over 76 billion cyber threats blocked daily and over 132,000 paying customers in total. I also like the fact that the company generates 47% of its revenue outside of the US market. Too much concentration on a large market is too risky and can be subject to fierce competition.
Cloudflare’s customer base in over 175 countries is a clear signal of a very successful implementation of a scalable business plan. Cloudflare considers the four main elements of its competitive advantage to be: shared intelligence, network scale, ease of use, and no compromise in security and performance.
Coincidentally, their growth strategy is also based on four key pillars. Starting from the obvious of acquiring more customers, expanding relationships with existing customers, investing to develop new products, and expanding the serverless platform strategy.
Future growth areas considered incremental, which is very good news for any type of business, include the Internet of Things (IoT), 5G technology, and consumer preferences and trends.
Cloudflare: the bearish scenario
In a nutshell, the main argument for being bearish on NET stock is its high valuation. Before we go into more detail on the valuation, it’s worth mentioning that Cloudflare in Q3 2021 saw lower numbers as a percentage of revenue for sales and marketing, research and development, and general and administrative expenses. respectively compared to 2020.
These numbers above are important as they are inputs to calculate operating profit. The expectation of an improvement in operating profit in the third quarter of 2021 is logical. Unfortunately, for the nine months ended September 30, 2021, Cloudflare reported an operating loss ($86.62 million) greater than ($82.02 million) for the nine months ended September 2020.
Cloudflare also reported a growing net loss of $182.8 million for the first nine months of 2021, compared to a loss of just $85.34 million for the same period a year ago. This is an increase of more than 110%.
Other significant key risks are share dilution, as the total number of shares outstanding has increased by 4.7% over the past year and a cash burn issue.
When it comes to valuation, two important financial measures are price-to-sales and price-to-cash flow ratios. Cloudflare has a Price to Sales (FWD) ratio of 39.82 and a Price to Cash Flow (FWD) ratio of 727.91. The information technology sector has median values of 3.60 for price/sales and 20.73 for price/cash flow respectively. I consider this very large premium for NET stocks to be unjustified.
I’m on the bear side on net stock
Investors need more than just income. Like earnings and an attractive valuation, Cloudflare clearly lacks these factors. Cloudflare is in the category of companies with great products but not great inventory.
Cloudflare stock is already posting losses of around 39% year-to-date. It is still too expensive and should strive to turn a profit quickly because in 2022 value stocks have every chance in their favor and growth stocks trading at high prices are set to have a very tough year.
Investors who want to buy shares NET must be very patient and prefer strong sales. The reality is that the NET stock is too rich now. Remember: buying an overvalued stock for a small discount barely mitigates the total risk.
As of the date of publication, Stavros Georgiadis, CFA does not hold (either directly or indirectly) any position in the securities mentioned in this article. The opinions expressed in this article are those of the author, subject to InvestorPlace.com Publication guidelines.
Stavros Georgiadis is a CFA charter holder, equity research analyst and economist. He focuses on US stocks and has his own stock market blog. laborsesoninternet.com. He has written various articles for other publications in the past and can be reached on Twitter and on LinkedIn.